Commissioner of Income Tax vs Kusum Products Ltd.

Ajit K. Sengupta, J.—In this reference u/s 256(1) of the income tax Act, 1961 (''the Act'') for the assessment year 1980-81 the following questions of law have been referred to this Court:

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in that the commission of Rs. 3,82,959, Brokerage of Rs. 39,952 and Salesmen''s Travelling Expenses of Rs. 5,09,739 should not constitute the Sale Promotion expenses so as to fall within the ambit of section 37(3A) of the income tax Act, 1961?

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the ITO was not justified in making addition of Rs. 34,198 out of export of machineries to P.T. Kusum Products, Indonesia, by invoking the provision of section 92 of the income tax Act, 1961?

It is not in dispute that the first question is now concluded by the decision of this Court in the case CIT v. Hindusthan Motors Ltd. (IT Reference No. 134 of 1985, dated 23-2-1990]. Following the said decision we answer the first question in this reference in the affirmative and in favour of the assessee.

The facts relating to the second question are that during the relevant accounting year the assessee-company made transaction with P.T. Kusum Products, Indonesia, a non-resident company, in selling the equipments and machineries. The value of the machineries was Rs. 2,00,805 (Rs. 2,63,398 minus Rs. 62,593 including freight, port and other charges to the tune of Rs. 31,306). The machineries were stated to have been sold at Rs. 1,66,607. The ITO found that the business of selling machineries and equipments was carried on, as in earlier year, between the resident-assessee and the non-resident, P.T. Kusum Products, Indonesia, and there was close connection between the resident- assessee and the non-resident company. Thus, the sale of machineries and equipments was so arranged that the transaction between them produced no profit at all, rather there was a loss of Rs. 34,198 to the resident-company. So the ITO invoked the provision of section 92 of the Act and Rs. 34,198 (Rs. 2,00,805 - Rs. 1,66,607) was added and included in the assessment as income of the assessee during the year.

The assessee preferred an appeal before the Commissioner (Appeals) against the decision of the ITO. The Commissioner (Appeals) following the order of the Tribunal on this issue for the earlier assessment years deleted the addition made by the ITO.

The department then preferred an appeal before the Tribunal against the decision of the Commissioner (Appeals) and the Tribunal also following its order for the assessment years 1977-78 and 1978-79 in the assessee''s own case upheld the order of the Commissioner (Appeals).

The question which calls for determination is whether section 92 has any application to the facts of this case.

Mr. Moitra, the learned counsel appearing for the revenue, has contended that the Tribunal has not considered section 9(1) of the Act which is relevant as there is a business connection; since the Tribunal did not advert to this aspect of the matter, the matter may be remanded to the Tribunal for fresh consideration.

We are afraid that this argument is based on misconception of the facts. There is no dispute in this case that the assessee being a resident-company had income from the transactions made in Indonesia. The question is whether on the facts found by the Tribunal section 92 has any application or not.

Mr. R.N. Bajoria, the learned counsel appearing for the assessee, has contended that section 92 cannot be applied in the present case as the assessee was not dealing in plant and machinery. The assessee''s business was a different one. It only established a new company in Indonesia with others. He has also highlighted the facts and circumstances as appearing from the orders of the authorities below.

We have considered the rival contentions. Section 92 provides as follows:

Where a business is carried on between a resident and a non-resident and it appears to the income tax Officer that, owing to the close connection between them, the course of business is so arranged that the business transaction between them produced to the resident either no profits or less than the ordinary profits which might be expected to arise in that business, the income tax Officer shall determine the amount of profits which may reasonably be deemed to have been derived therefrom and include such amount in the total income of the resident.

It is necessary to consider the provisions in the light of the agreement.

Under article 3 of the agreement authorised capital of the new company to be established at Indonesia shall be US $ 10,00,000 divided into 10,000 shares of US $ 100 each. The assessee and two other companies shall subscribe and pay for, at par, the shares to be issued by the new company in the following ratio:

(a) KPL-assessee - 50 per cent

(b) West German company - 30 per cent

(c) Indonesian company - 20 per cent.

On incorporation, 200 shares of US $ 100 each will be subscribed by the promoters on which 10 per cent shall be paid up initially. The promoters shall arrange for the subscription of the remaining capital of the company and the amount to be called up on the shares shall be determined by the promoters as and when required for the purpose of the company. The authorised capital of US $ 10,00,000 shall be fully paid up in accordance with the decisions of the Board of Commissioners but within two years from the date of incorporation of the company. Provided the capital has not been paid up as per decisions of Board of Commissioners, an interest at the rate of 2 per cent per month will be charged by the company until the respective amount has been fully received. This interest will be applicable if payment is delayed beyond 21 days of call.

The payment for the shares subscribed and paid up shall be made either in cash or in kind as may be agreed by the promoters. The amount of share money payable by KPL shall be exclusively in the form of machinery and plant and equipment coming in from India and for any other expenditure in connection therewith, for which KPL will submit proof.

Clause (v) of the letter of the RBI dated 28-7-1975 which being relevant is extracted below:

(v) Your contribution of US $ 5,00,000, i.e., approx., Rs. 37.50 lakhs, towards equity share capital shall be by way of export of new and indigenous items of plant and machinery out of the list enclosed herewith.

As indicated early, the assessee along with Peter Cremer of West Germany established a new limited company, P.T. Kusum Products in Inonesia. The authorised capital of the company was US $ 10,00,000. There were three promoters - the assessee, the West German company and Teknik Umum P.T. of- Indonesia. The share capital of the new company was U.S. $ 10,00,000. The assessee-company, the West German company and Indonesian company were to share 50 per cent, 30 per cent and 20 per cent, respectively, of the share capital. The assessee-company was thus to subscribe US $ 5,00,000 towards the capital of the new company which was going to be established in Indonesia. The RBI did not allow the assessee- company to drain out foreign exchange and vide its letter dated 28-7-1975 directed the assessee-company to invest the required capital by export of plant and machinery and equipment. This was also approved by the Ministry of Commerce, Government of India. Pursuant to the agreement dated 13-3-1975 and the approval of the RBI and Ministry of Commerce, Government of India, the assessee participated in the new company by contributing its capital by way of exporting plant and machinery and equipment. The assessee was entitled for export incentive and moreover the prices of plant and machinery, it was reported, which were to be exported towards the capital of the assessee, as quoted by the assessee, were high. The assessee took into consideration the export incentive which it was to get on the export of the plant and machinery and, accordingly, though the machineries were purchased for Rs. 67,74,174. It charged Rs. 50,34,645 from the new company including freight. However, the assessee further received the export incentive of Rs. 7,91,331. Thus, the assessee contributed towards its capital in kind. The purpose of exporting machine to the new company in Indonesia was not to earn any profit and/or loss on the transaction. The only purpose of exporting the machinery was to contribute towards the capital as per agreement and as per the approval of RBI and the Ministry of Commerce, Government of India.

The ITO added to the sale proceeds of the plant and machinery the export incentive. This is not warranted by the provisions of the Act. Section 92 is applicable where it is found by the ITO that in a business deal between a resident and non-resident due to the close connection between the parties, the business is so arranged that the business did not result in profit or resulted in less profit than the ordinary profit which might have been earned in the regular course of business and in that event, it is the duty of the ITO to estimate the fair profit. On analysis of section 92 it will appear that there are five ingredients of this section which are as follows:

(i) The transaction may be between a resident and a non-resident.

(ii) It should be a business transaction.

(iii) The business may be with the motive of profit.

(iv) The profit earned by the assessee may not be fair due to the close relation.

(v) The ITO in such a situation may estimate the fair profit.

There is no dispute that it was a transaction between a resident and a non-resident but other ingredients of this section are not applicable to the facts of this case. As rightly contended by Mr. Bajoria, that there is no business transaction between the assessee and the non-resident company. The assessee did not export machines as a seller to a buyer. The assessee had contributed its share of capital in kind as permitted by the RBI and the Ministry of Commerce, Government of India. The question of profit and/or loss may not arise when one is contributing towards capital. If it was not a business transaction with a motive of profit, the ITO was not competent, in such a situation, to consider whether there was a profit or the profit earned by the assessee was fair or not. It was merely a capital contribution in the form of plant and machinery. The contribution of capital, in no circumstances, will result in profit. The profit will only arise after exploitation of the plant and machinery and when the resultant product is sold in the market. There is no finding that the transaction was under-estimated or over-estimated. There is no dispute that the assessee exported plant and machinery and equipment towards its capital participation in the capital structure of the new company.

In our view, on these facts the Tribunal was justified in holding that the provisions of section 92 have no application.

For the reasons aforesaid, the second question in this reference is answered in the affirmative and in favour of the assessee. There will be no order as to costs.

Banerjee, J.

I agree.